Thursday, 28 January 2016

Shortly after the full extent of the financial crisis had become clear, I remember saying in a meeting that at least now the position of those who took an extreme neoliberal position (markets are always right, the state just gets in the way of progress) would no longer be taken seriously. I could not have been more wrong. But in a way I think that the ‘surprising’ strength of the radical left (by which I mean those who are not the established centre left) in the US, UK and perhaps some European countries reflects exactly this contradiction.

We need only to consider the position of the financial sector to understand this contradiction. That sector was by far the major cause of the largest recession since WWII, and yet it is now in essentially the same position as it was before the crisis. There are no purely economic reasons why this has to be so: economists know that it is perfectly possible to make fundamental changes to this sector that could significantly reduce the chance of another crisis at little cost, but such possibilities are just not on the political agenda. For example, Admati and Helwig have convincingly argued that the problem with banks is very low capital requirements, but actual reforms have been marginal.

The reason is straightforward: the financial sector has political power. Many on the centre left seem too timid or too ignorant to talk about this power publicly, and are therefore unwilling to challenge it. The political right and it's media machine help divert those who have little interest in politics and economics into believing that their problems are really due to too many migrants or too generous welfare payments. Those who are members or supporters of left wing political parties tend to have a better understanding of what is going on. To put it simply, a sector that caused a great deal of harm and cost us all a great deal has got away largely unscathed such that it could easily do it all again.

But it gets much worse. The right has succeeded in morphing the financial crisis into an imagined crisis in financing government debt (or, in the Eurozone with the ECB’s help, into an actual crisis) which required a reduction in the size of the state that neoliberals dream about. The financial crisis, far from exposing neoliberal flaws, has led to its triumph. Confronted with this extraordinary turn of events, many of those on the centre left want to concede defeat and accept austerity!

That is all scandalous, and if the left’s established leaders will not recognise this, it is not surprising that party members and supporters will look elsewhere to those who do. Now wise heads may warn that the radical left has in many cases not grasped the nature of the problem and are simply repeating old slogans, and worse still that voting for radical leaders may deny the left the chance for power, but inevitably this can sound just like the appeasement of many on the centre left. What Corbyn’s victory shows Democrats in the US is the power of the contradiction between the global financial crisis and where we are now.

Sunday, 24 January 2016

I have argued
that the low level of German wage increases before the financial
crisis were a significant destabilising influence on the Eurozone,
which also indirectly contributed to Germany taking a hard line on
austerity. The basic idea is that Germany gained a significant
competitive advantage over its Eurozone neighbours, which it has
since been unwilling to unwind (through above average German
inflation). What this competitiveness gain did was lead to very
healthy export growth and a large current account surplus, and that
additional demand meant that Germany did not suffer as much as its
neighbours from the second Eurozone recession that policy created.
Peter Bofinger has made a similar
argument.

This argument is often criticised on the grounds that Germany’s
healthy export growth was not primarily due to any competitive
advantage, but instead was the result of non-price factors like
strong demand from China for the type of goods Germany produces. This
and other criticisms were recently made in a paper
by Servaas Storm. One of the points made by Storm has itself been
criticised
by Thorsten Hild, and Hild’s point is entirely correct (see also
Storm’s reply here).
But the issue about what was the primary cause of strong export
growth remains.

Trying to disentangle how much of German export growth was due to the
competitiveness advantage they gained would require some econometric
analysis which unfortunately I do not have time to undertake. But the
point I want to make here is that if there has been a permanent
positive shift in Germany’s exports (i.e one unrelated to price or
cost competitiveness), then this strengthens the argument that I have
been making. Before we get there, it is worth going through the basic
macroeconomics involved.

Every country will tend towards some long run level of
competitiveness. There are many ways of describing why this is: the
need to obtain a balance between the production and demand for
domestically produced goods, or the need to achieve a sustainable
current account deficit. There are many reasons why this long run
level of competitiveness could change over time, but in the absence
of a plausible story about why that has happened to Germany (or
equivalently, why a 7% of GDP current account surplus might be
sustainable) it seems reasonable to assume that it has remained
unchanged.

So if an economy in a monetary union, like Germany, moderates wages
so that it gains competitiveness in the short term (where the short
term could last a decade), this gain has to be unwound at some point.
Just as the decline in competitiveness in the periphery needs to be
reversed by creating below Eurozone average inflation there, the
opposite applies to Germany.

Now suppose there has in fact been a permanent upward shift in the
overseas demand for German goods. In the long run if nothing changed
we would have an imbalance: the demand for German goods would exceed
the supply, or the current account surplus would be unsustainable.
The way the economy reacts to get rid of that imbalance is through
additional German inflation. Not only must past gains in
competitiveness be reversed, but competitiveness must decline even
further to reduce the demand for German goods.

For those brought up on a mantra of the need to constantly improve
competitiveness, this may seem perverse: getting punished for making
goods other countries want. But of course it is not punishment at
all. A decline in competitiveness is the same thing as an
appreciation in the real exchange rate, and this makes consumers
better off, because overseas goods become cheaper (in the jargon,
there is a terms of trade gain). It is time for Germany to export a
bit less, and start enjoying the benefits.

Posting note

For various reasons
over the next month the frequency of posts may diminish. Don’t go
away - I will be back.

Thursday, 21 January 2016

Those who care to see know the real damage that austerity has had on
people’s lives. From those needing care who now
get so little, to those waiting longer
for hospital treatment, and those whose homes might not have been
flooded without the cuts
from 2011. There is nothing unusual about the UK in this respect:
austerity (cuts in spending that are either mistimed or unnecessary)
causes
harm, wherever it is imposed. But the political cost has also been
huge.

This is true in the Eurozone, but in this post I want to focus on the
UK. The cost on the left could not be greater. Austerity and the
reaction to it were central to Labour losing the election. The
Conservatives managed to pin the blame for Osborne’s austerity on
Labour, and as the recent Beckett report
acknowledges (rather tellingly): “Whether implicitly or explicitly
(opinion and evidence differ somewhat), it was decided not to
concentrate on countering the myth … ” It was also central in
the revolution of the ranks that happened subsequently.

Austerity is a trap for the left as long as they refuse to challenge
it. You cannot say that you will spend more doing worthwhile things,
and when (inevitably) asked how you will pay for it try and change
the subject. Voters may not be experts on economics, but they can
sense weakness and vulnerability. If instead you restrict yourself to
changes at the margin, you appear to be ‘just the same’.

I think many of those on the centre left still do not see this trap.
There are some problems you cannot triangulate around, but have to
tackle head on. Here is a recent example
from Rachel Reeves. Much of what she proposes, when she talks about
securing the necessary investment in flood defences for example,
makes total sense, but it also tends to cost money. Rather than
confront Osborne’s unnecessary cuts, she talks about a failure “to
demonstrate that we understood that dealing with the deficit and
controlling public spending are the precondition of effective
progressive government.”

The urge to move on,
and not talk about the dry subject of the public finances, is quite
understandable and not confined to the parliamentary Labour party.
Hereis Mariana Mazzucato giving a brief summary of her excellent innovation agenda for Labour (or indeed any political party that is not hamstrung by a neoliberal romantic view that technical advance is all down to the entrepreneur and the state just gets in the way, a view completely destroyed by her excellent book). I was struck by the juxtaposition of the following two sentences:

“Likewise, it is time to move on from the debate over austerity to a new conversation about how to build smart, mutually beneficial public-private partnerships to fuel decades of growth.For starters, we must invest in education, human capital, technology, and research.”

But of course it becomes so difficult to achieve that investment when
the dead hand of austerity is demanding cuts from everything it
touches.

That dead hand is not just left handed, but touches the reformist
right just as it does the left. Some regard David Cameron’s
speeches that talk about reducing the causes of poverty and social
deprivation as just window dressing, but I agree with RaphaelBahr
that these come from a genuine desire on his part to be remembered as
a socially reforming prime minister. Yet as a result of austerity
such speeches seem ridiculous now, and will only be disregarded by
history: meaningless when set aside the reality of the poverty and
harm caused by government actions. Here is a self explanatory chart
from
the IFS.

There were genuine hopes on all sides that Universal Credit (UC)
might achieve the aim of simplifying the benefit system, and thereby
reduce the number who fail to claim benefits they are entitled to and
need. But as a result of austerity, and those cuts to tax credit that
the Chancellor was forced to postpone, UC will now be seen as a way
of cutting benefits and will be either extremely unpopular and/or be
quickly killed. It would be useful to be able to assess what aspects
of the health reform brought in by the coalition worked and which did
not, but I suspect all that will be lost in the chaos caused by
underfunding.

So the dead hand of austerity kills hope of reform from both left and
right. The years of austerity will be seen as wasted years, when no
new progress was achieved and plenty that had been achieved in the
past setback. Recovery from recessions need not be like this, and
indeed has not been like this in the past. They can be a time of
renewal and reform: if not from a credit squeezed private sector then
at least from government. And it could have been like that again,
because there was absolutely no necessity to embark on
austerity in the depth of a recession.

Those on the right may say well at least we are getting a smaller
state. But attempts to force people to in effect spend less on health, education, justice and even a welfare state, are not durable for more
than a decade or two. It will be a hollow victory.

In the US and most
of Europe the obsession with austerity is coming
to an end. It is still killing Greece and holding back Germany, but
elsewhere deficit targets are either being achieved through growth or
quietly ignored. Yet in the UK that dead hand continues, seen or
unseen, to dominate policy and debate. And with its architect set to
become Prince Minister and large parts of the opposition still too
timid to challenge it, it looks like another five wasted years lie
ahead for us.